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FDI, Financial Development, and Economic Growth: International Evidence

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  • Chien-Chiang Lee
  • Chun-Ping Chang

Abstract

Previous studies have recognized that the benefits from foreign direct investment (FDI) to recipient countries can only be realized when those countries have reached a certain level of financial development. However, the dynamic interrelationships among FDI, financial development, and real output, including the long-run equilibrium as well as causality, have not been analyzed. This paper overcomes this major shortcoming by applying recent advances in panel cointegration and panel error correction models for a set of 37 countries using annual data for the period 1970–2002. For the first time, we explore the directions of causality among FDI, financial development, and economic growth and obtain solid, convincing evidence of a fairly strong long-run relationship. Furthermore, the financial development indicators have a larger effect on economic growth than does FDI. From the panel causality tests, while the evidence of a short-run relationship is weak, that of a long-run relationship among the variables is unequivocal. Overall, the findings underscore the potential gains associated with FDI when coupled with financial development in an increasingly global economy.

Suggested Citation

  • Chien-Chiang Lee & Chun-Ping Chang, 2009. "FDI, Financial Development, and Economic Growth: International Evidence," Journal of Applied Economics, Taylor & Francis Journals, vol. 12(2), pages 249-271, November.
    • Handle: RePEc:taf:recsxx:v:12:y:2009:i:2:p:249-271
    DOI: 10.1016/S1514-0326(09)60015-5
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    JEL classification:

    • F23 - International Economics - - International Factor Movements and International Business - - - Multinational Firms; International Business
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • O40 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General

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